And Speaking of Insider Trading, Remember Those Forward Sales?

by: Mark McQueen

Think back just over ten years ago. It’s February 2000, with the NASDAQ at 4,900. Imagine a Canadian CEO of a publicly-traded technology company on a roadshow to discuss the last quarter, and give Portfolio Managers a sense of what the new year will bring in the wake of a 2,000 point NASDAQ sell-off, before recovering.

Prior to the meeting, the PM checked the SEDI records for the company, and saw that the CEO had sold just 15% of his company stake “for estate planning purposes” in 1999. Quick math meant that the CEO had cleared maybe $8 million pre-tax, which didn’t sound like a big number compared to the one-time $240 million value of the CEO’s unsold nut. At the current share price, he still had $180 million at risk.

The session goes fine, and the PM decides to hold her position. Partly because she and the CEO are riding it out together.

A year later, or maybe two, the PM hears a story about her Tech CEO plunking down $5 million for a vacation home. Hmmm, she thinks. Where did that money come from?

The answer? A Forward Sale. In 1998, 1999, and early 2000, some Canadian executives were busy hedging their positions with what were called “Forward Sales”. Local bank XYZ would enter into an agreement with the CEO or CFO to sell, say, $80 million of the CEO’s stock in 5 or 10 years at the current price. In the meantime, the CEO retained ownership of the stake, including voting rights. And it was all tax free until the expiry of the Forward.

According to the securities regulations of the time, it wasn’t deemed a sale. Even though the CEO had removed the risk on $80 million of his stake in the company. Because it hadn’t yet been sold, at least technically, no insider filing was required. When the company’s shareholders went to check the SEDI filings, they had no idea that the CEO was financially indifferent to the NASDAQ’s plunge. So when the CEO was bullish about the future of the company and its financial prospects, the PM mistook that confidence to mean that she and the CEO were in the same financial boat.

They weren’t, of course. But no one knew, and no one was rude enough to pry.

Eventually, one day last decade, the Regulators decided this was no longer accurate — let alone fair — and required Forward Sales to be disclosed. Not that it ever was fair to start with, even if it was considered legal. Some CEO’s retained their Forward Sale positions and disclosed. Others closed out the forward; with the NASDAQ down to 1,500 it meant they could now have the money AND get back almost all of their shares. With the option grants that had accumulated in the interim, it became very hard to figure out who had utilized and closed out their Forward Sales while they were in vogue.

All of this was legal. Then, one day, regulatory folks realized it wasn’t really fair. We are not talking 1950, either. This was practically yesterday in the world of modern day market enforcement.

Which comes to mind with the FBI’s interest in Supply Chains, and the insight they can give certain people into the fortunes of small and large public companies (see prior post “What will become of channel checks?” Nov 23-10). Particularly publicly-traded tech names.

That’s how it goes sometimes. One day something’s legal, and then the next day everyone realizes that it’s just not fair.